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Why the Best Is Yet to Come for Netflix, Inc.

The streaming giant has built a foundation that sets it up for long-term success.

Netflix (NASDAQ:NFLX) has grown from a humble DVD-delivery service into a product that has changed how first Americans, then the world, consume content.

The company has done something many successful businesses have failed to do. It transformed itself, moving away from a successful business model to one that had significant risks.

Netflix could have easily met the same fate as Blockbuster Video, a company it first disrupted, then helped put out of business. Had the streaming leader clung to its DVD-delivery model, it would either no longer exist, or it would be a small, niche player sending hard-to-find films to enthusiasts.

Instead, by pivoting its business to streaming, and then taking the further risk of committing billions to original content, Netflix has grown to just-under 99 million total subscribers and 94.36 paid memberships at the close of its first quarter of 2017.

Netflix added about 4 million paid memberships in Q1, down from the same period last year, which it blames on the timing for the new season of House of Cards. Despite that the company said in its Q1 letter to shareholders that it expects roughly the same growth through the first six months of 2016.

"We have come to see these quarterly variances as mostly noise in the long-term growth trend and adoption of internet TV," the company wrote. "For the first half of this year, for example, we expect to have 8.15 million net adds, compared to 8.42 million net adds in the first half last year."

The company has had tremendous growth, but it has not plateaued. Instead, the reasons it has grown create a base for future success.

Netflix has become the leader among all streaming companies. Image source: Netflix.

A growing library of originals

When a streaming service licenses a show, it generally buys the rights to it for a specific period of time. That program may draw in some audience, but eventually, the agreement expires, and either a new one has to be reached, or the content must leave the platform.

By creating original programs, Netflix builds its asset library. The company may have higher up-front fixed costs but most of its originals will have value to new viewers for an extremely long time. A show like Daredevil or Orange Is the New Black may be a major draw currently, but to a consumer considering Netflix a decade from now, who has not seen either series, both should still be worth watching.

As time passes and Netflix grows its library of originals, it becomes more appealing to non-subscribers. Even if you only like a specific genre, the streaming giant will ultimately have at least a handful of shows in its archive that make joining worth it. The company is building a programming library that increases its appeal while also making it hard for anyone else to compete.

Global expansion

Netflix still has more than half of its subscribers in the U.S. Going forward, the streaming service, which is available in nearly 200 countries, should be able to continue to rapidly grow across the world.

The company can do that in a number of ways, including producing more market-specific international content. In addition, Netflix can simply offer its originals in more languages, increasing the service's appeal across the world. Management was excited about its international growth prospects in its Q1 letter to shareholders, even as net additions decreased 22% year over because the company "lapped" its January 2016 launch in over 130 countries:

"Revenue for the international segment grew 62% year over year, excluding a -$12 million impact from currency, while ASP rose 12% year over year on a F/X neutral basis," the company wrote. "Q1 was the first quarter of consolidated profit for our international segment as profit growth in our more mature territories offset investments in newer markets."

The company actually forecasts a slight loss in its international territories for the full year due to continued investment. That said, much like its original content base benefits from slow growth over time, so too will its localized efforts to offer market-specific content.

A strong base for the future

Netflix has created a global business with a strong library of assets. It has disrupted the traditional cable model and made itself a good value to existing customers that becomes ever more valuable to potential new subscribers.

Going forward, it's hard to see what rival content providers can do to compete. That's not to say Netflix has no rivals. Hulu, Amazon Prime, and HBO are, of course, competitors, and a rumored service from Comcast along with potential partners, could have a strong catalogue of content.

Still, even in a crowded space, Netflix has put itself in a position to build on its early lead. It has a strong current lineup of originals that's unmatched by even HBO, and it's building an archive that matches the one owned by the pay channels. Perhaps most importantly, unlike its rivals' programs, Netflix's have never been sold to traditional television.

That's an important difference since it means if consumers want to see Netflix originals, they have to subscribe to the streaming service. As the number of programs in its archive grow, those, plus whatever new shows it has launched, should help Netflix continue its steady growth around the world.

Daniel Kline has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Netflix. The Motley Fool has a disclosure policy.

Author

Daniel B. Kline is an accomplished writer and editor who has worked for Microsoft on its Finance app and The Boston Globe, where he wrote for the paper and ran the Boston.com business desk. His latest book, "Worst Ideas Ever," (Skyhorse) can be purchased at bookstores everywhere.
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